Bond market begins to reap benefits of interest rate cuts

Bond market begins to reap benefits of interest rate cuts

Mumbai: India’s cash-starved companies are slowly getting the benefit of the central bank-initiated interest rate cuts, as evident from the falling yields of the papers issued by them.

This, even as investors bet that rising government incentives to companies and possibly a further rate cut by the central bank means the worst may be over for shares.

Also See South Bound (Graphic)

Yields on the corporate papers registered a sudden plunge soon after the announcement of the stimulus package by the Reserve Bank of India and the Union government in the first week of December. Although it mirrors the movement of government papers of the same maturity, the yields were maintaining a high level even as yields on similar maturity government papers were steadily coming down after the first rate cut by RBI in October.

On Tuesday, yields on the 10-year government paper dipped below 6%, its lowest ever in four years, even as the similar maturity AAA rated paper was trading at its January level.

Although the yields on government bonds started falling rapidly after October when RBI started reducing its so-called cash reserve ratio, or CRR, and later its policy rate, the yields on the corporate bonds held steady and even increased to reach its peak this year in November. This as the credit crunch eased and liquidity improved in the banking system, though firms still struggled to raise funds in a falling stock market with banks also reluctant to extend credit.

However, post-November, the government initiated a slew of measures to help prop the sagging growth of the economy. As part of a stimulus package, the government last week announced a Rs31,900 crore package that included a 4% reduction in excise duties, selective interest subsidies on borrowing by exporters and a boost to infrastructure investments.

Interestingly, in just about 15 days, yields on the AAA-rated commercial papers have dipped to year-low levels even as yields on similar maturity government papers are falling steadily since October when the central bank started slashing banks’ CRR, or the portion of deposits that banks are required to maintain with the central bank in cash.

The yields on 10-year AAA-rated corporate bonds closed at 8.8151% on Tuesday, a sharp drop from its 1 December level of 11.0125% and 12 November peak of 11.7627%. In contrast, the 10-year government paper has fallen at least 3.5% since its July peak of about 9.5%.

Yields on the corporate issued papers closely mirror the government securities yields, albeit with a spread. Typically, this spread varies from 100 basis point to 200 basis points (one basis point is one-hundredth of a percentage point).

However, in November, when the government bonds was downhill and corporate papers were holding steady, the spread in 10-year papers widened to as much as 411 basis points. Now the spread is 274 basis points, which gives dealers to bet that spread on such papers will come down further.

“The yields on the corporate bond will fall even more from the present level," said S. Srinivasa Raghavan, head of treasury at IDBI Gilts Ltd, a firm that trades in government and corporate bonds. “The fall was always there, but the pace of fall has increased after the latest rate cuts."

Harihar Krishnamurthy, head of treasury at Development Credit Bank puts it more bluntly. “The government has signalled that companies in India will not be allowed to fail," he said. “Investors have realized that the cash-starved companies will not default on their commitment as government is behind them. This makes corporate bonds more attractive at these level."

Increased participation of foreign institutional investors in corporate bonds may have also contributed to the drop in yields, say some bond dealers.

The finance ministry and RBI in October doubled FII investment limit in the corporate bond market to $6 billion (Rs28,680 crore) from $3 billion earlier. According to data released by capital market regulator Securities Exchange Board of India, or Sebi, foreign institutional investors bought a net of $1.04 billion in debt in November. This compares well with the previous month, when they were a net seller of $460.7 million in debt.

The falling yield is also prompting companies to raise funds through bonds. State Bank of India said on Tuesday that it would be raising Rs18,000 crore through bonds by March 2010. The bank is already set to raise on Wednesday 15-year upper tier II subordinated debt worth Rs2,000 crore at 8.90% interest. Given the dipping yield level, more banks are expected to follow suit to meet their increased capital requirement as per an international capital adequacy norm to be made mandatory by March.

“At this level, corporate bonds are an attractive investment opportunity. People may borrow from the call money market at 6% and invest in corporate bonds, a neat spread of about 3%," said Raghavan.

Although such bonds are a sure delight for the investors, corporations who have issued such papers are not elated.

“This is good for new issuers for companies who have issued the papers in acute need of fund in past few months, this does not make any difference," said a senior official at the treasury department of Bharat Petroleum Corp. Ltd.

J. Moses Harding, head of the wholesale banking group at IndusInd Bank Ltd, said the fall in yield is across the board but the sharp drop can be attributed to the suddenly improved liquidity condition.

“Such bonds can be issued still now, provided there is a risk appetite for such bonds," he said, adding that the supply of such bonds have far exceeded demand.

Graphics by Ahmed Raza Khan / Mint